To Bespoke Or Not To Bespoke

That, as one old market watcher might have suggested, is the question.

As we contemplate the condition of today’s market, “collateralized debt obligations” must surely give us pause. Among the industry’s most mysterious inventions, CDOs are structured financial products that allow dealers to pool cash flow-generating assets and repackage them into discrete tranches with varying risk profiles that can be sold to investors. A nice little soliloquy.

Bespoke is an adjective for anything commissioned to a particular specification

But not quite enough outrageous fortune, at least for Wall Street enterprises of great pitch and moment. Enter “bespoke CDOs”, stage right. These new characters are created for very specific investors to target very specific risk/return profiles for their very specific investment strategies. Pricing is typically calculated based on complex theoretical financial models, and there is little, if any, secondary market for these bespoke CDOs. Aye there’s the rub.

The launch of the bespoke product has reportedly been rising of late

Turns out the biggest risk to individual investors in a bespoke fund is not its shadowy performance, but a quick outflow of assets. In practice, if the firm for which these investments were created, say a Camas, Wash.-based investment advisor, sells its position, investors who remain can be left in a note or fund that’s more expensive to trade or one that could close and create a taxable event. A veritable sea of troubles.

No one actually knows how many bespoke exchange-traded products exist

Those troubles came to the fore last month when the aforementioned advisor pulled $300 million from a $330 million customized Deutsche Bank exchange-traded note, leaving remaining investors with a virtually untradeable security, a mere apparition of its former self. A good reminder to “bear those ills we have than fly to others that we know not of.”

What the markets have been doing…

Two words for the two weeks: Postelection rally. Boosted by expectations of a better growth outlook, stocks of all stripe moved higher across the period. Smaller caps performed best, building on their lead for the year. The technology-heavy NASDAQ touched a new record early Friday. Financial stocks, expected to benefit from the new administration and helped by higher bond yields, generally outperformed.

Away from the political front, the period’s reports indicated the economic picture remains relatively bright. Retail sales rose solidly in October, and housing starts shot up 25%, with new housing permits seeing their best monthly rise since 1982. Weekly jobless claims also set a favorable multi-decade record by falling to a 43-year low. Fed Chief Yellen indicated that recent economic signals have been strong enough for the Fed to raise rates at its December meeting.

Index

Friday’s Close

Two-Week Point Change

Year-to-Date Change

DJIA

18867.93

+979.65

+8.28%

S&P 500

2181.90

+96.72

+6.75%

NASDAQ

5321.51

+275.14

+6.27%

Over in the bond market, rising yields hurt Treasury prices, with longer-maturity issues touching their highest levels in a year. Investment-grade corporates, on the other hand, drew strong interest from overseas investors, providing good support for the market. High-yields benefited from an active exchange-traded fund market, where new issues were met with strong demand. Municipal bonds fared poorly across the two-week stretch, particularly in lower-rated issues.

Fixed Income

Yield

Two-Week Yield Change

2-Year Treasury

1.08%

+0.26%

10-Year Treasury

2.33%

+0.52%

30-Year Treasury

3.00%

+0.41%

30-Year Municipal Bonds

3.10%

+0.53%

I’d like to be home for Christmas…

If anything like the new administration’s proposed 10% tax rate on cash brought back from overseas were passed, it could result in $500 billion returning to the U.S.

Quotes of the Week…

TSA Administrator Peter Neffenger on the Sunday after Thanksgiving, the busiest travel day of the year:

The obvious: “I suspect there will be big crowds in airports. It’s just a big, crazy time of year for travel.”

The oblivious: “We think we’re ready.”

Number of the Week…

4%

The euro’s drop against the dollar over the last two weeks

What Fund Architects has been doing…

As we write this, the S&P 500, Dow Jones Industrial Average, and the NASDAQ Composite are climbing toward a trifecta of record closing highs. Indeed, stocks have rallied since the election, with major indexes advancing two weeks in a row through Friday. Investors have piled into stocks betting that President-elect Trump will loosen regulation and boost infrastructure spending. At the same time, they’ve pulled back from Treasuries and stock-market bond proxies, which are less attractive to investors when interest rates rise.

From here, it’s reasonable to expect a fair amount of volatility in the coming weeks and months as the new administration rolls out its ideas to the markets. Already, we’re seeing some areas up big, while others are down big.

We have to think there is much alpha to added in this kind of environment by our adaptive management approach. Already, our systematic process took us to big equity positions in Global Technology and Global Financials, both of which have outperformed. On the fixed income side, we moved to Convertible Bonds and Senior Bank Loans, both of which have, too, outperformed.

Like we said two weeks ago, markets like these provide good investment opportunities if you can identify them.

The views in this commentary are those of Fund Architects. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product made reference to directly or indirectly in this commentary, will be profitable, equal any corresponding indicated historical performance level(s), or be suitable for your portfolio. Moreover, you should not assume that any discussion or information provided here serves as the receipt of, or as a substitute for, personalized investment advice from Fund Architects or any other investment professional. The information contained within this commentary should not be the sole determining factor for making investment decisions. To the extent that you have any questions regarding the applicability of any specific issue discussed to your individual situation, you are encouraged to consult with Fund Architects. Information pertaining to Fund Architects advisory operations, services, and fees is set forth in Fund Architect current disclosure statement, a copy of which is available upon request. Fund Architects, LLC is an SEC Registered Investment Advisory Firm.